Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, Sun Pharmaceutical Industries Limited (NSE:SUNPHARMA) does carry debt. But the real question is whether this debt is making the company risky.
When Is Debt A Problem?
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.
How Much Debt Does Sun Pharmaceutical Industries Carry?
You can click the graphic below for the historical numbers, but it shows that Sun Pharmaceutical Industries had ₹17.8b of debt in September 2021, down from ₹54.7b, one year before. But on the other hand it also has ₹105.5b in cash, leading to a ₹87.6b net cash position.
How Healthy Is Sun Pharmaceutical Industries' Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Sun Pharmaceutical Industries had liabilities of ₹148.1b due within 12 months and liabilities of ₹17.8b due beyond that. Offsetting this, it had ₹105.5b in cash and ₹101.3b in receivables that were due within 12 months. So it can boast ₹40.8b more liquid assets than total liabilities.
This surplus suggests that Sun Pharmaceutical Industries has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Sun Pharmaceutical Industries has more cash than debt is arguably a good indication that it can manage its debt safely.
In addition to that, we're happy to report that Sun Pharmaceutical Industries has boosted its EBIT by 47%, thus reducing the spectre of future debt repayments. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Sun Pharmaceutical Industries can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Sun Pharmaceutical Industries has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, Sun Pharmaceutical Industries produced sturdy free cash flow equating to 71% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.
While it is always sensible to investigate a company's debt, in this case Sun Pharmaceutical Industries has ₹87.6b in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 47% over the last year. So is Sun Pharmaceutical Industries's debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Be aware that Sun Pharmaceutical Industries is showing 2 warning signs in our investment analysis , you should know about...
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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